Benefits for Servicemen and Women Under the Military Family Tax Relief Act of 2003

By Mark H. Levin

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The following is an abridged summary taken from the Joint Committee on Taxation’s Technical Explanation of H.R. 3365, the “Military Family Tax Relief Act of 2003,” as Passed by the House of Representatives and the Senate (JCX-99-03), November 7, 2003.

Exclusion of Gain on the Sale of a Principal Residence

Under current law, an individual taxpayer may exclude up to $250,000 ($500,000 if married filing jointly) of gain realized on the sale or exchange of a principal residence. Prior to MFTRA, to be eligible for the exclusion the taxpayer must have owned and used the residence as a principal residence for at least two of the five years ending on the sale or exchange. A taxpayer who fails to meet these requirements because of a change in place of employment, health, or, to the extent provided under regulations, unforeseen circumstances, is able to exclude an amount equal to the fraction of the $250,000 ($500,000 if married filing jointly) that is equal to the fraction of the two years that the ownership and use requirements are met (see IRC section 121).

Effective for sales or exchanges after May 6, 1997, MFTRA permits an individual to elect to suspend, for a maximum of 10 years, the five-year test period for ownership and use during certain absences due to service in the uniformed services or the foreign service. If the election is made, the five-year period ending on the date of the sale or exchange of a principal residence does not include any period up to 10 years during which the taxpayer or the taxpayer’s spouse is on qualified official extended duty as a member of the uniformed services or foreign service. For these purposes, qualified official extended duty is any period of extended duty while serving at a place of duty at least 50 miles from the taxpayer’s principal residence, or under orders compelling residence in government-furnished quarters. Extended duty is defined as any period of duty pursuant to a call or order to such duty for a period in excess of 90 days or for an indefinite period. The election may be made with respect to only one property for the suspension period.

Exclusion of Certain Death Gratuity Payments

Before MFTRA, qualified military benefits were not included in gross income. Generally, a qualified military benefit is any allowance or in-kind benefit (other than personal use of a vehicle) which is received by any member or former member of the uniformed services of the United States or any dependent of such member by reason of such member’s status or service as a member of such uniformed services, and was excludable from gross income on September 9, 1986, under any provision of law, regulation, or administrative practice in effect on such date.

Generally, other than certain cost-of-living adjustments, no modification or adjustment of any qualified military benefit after September 9, 1986, is taken into account for purposes of this exclusion from gross income. Qualified military benefits include certain death gratuities, with the level of the death gratuity exclusion set at $3,000 since September 9, 1986. The amount of the military death gratuity benefits has been increased since September 9, 1986, to $6,000, pursuant to Chapter 75 of Title 10 of the United States Code. The amount of the exclusion from gross income, however, was not increased to take into account this change.

Effective for deaths occurring after September 10, 2001, the amount of the death gratuity payable under Chapter 75 of Title 10 of the United States Code was increased to $12,000. MFTRA extended the exclusion from gross income to any adjustment to the amount of the death gratuity payable under Chapter 75 of Title 10 of the United States Code that is pursuant to a provision of law enacted after September 9, 1986, with respect to the death of certain members of the armed services on active duty, inactive duty training, or engaged in authorized travel—effectively increasing the current amount of the exclusion to $12,000.

Homeowners Assistance Program Payment

The Department of Defense Homeowners Assistance Program (HAP) provides payments to certain employees and members of the Armed Forces to offset the adverse effects on housing values that result from a military base realignment or closure.

In general, under HAP, eligible individuals receive either: 1) a cash payment as compensation for losses that may be or have been sustained in a private sale in an amount not to exceed the difference between 95% of the fair market value of their property prior to public announcement of the intention to close all or part of the military base or installation and the fair market value of such property at the time of the sale; or 2) the purchase price for their property, an amount not to exceed 90% of the prior fair market value as determined by the Secretary of Defense or the amount of the outstanding mortgages.

Tax treatment: prior law. Unless specifically excluded, gross income for federal income tax purposes includes all income from whatever source derived. Amounts received under HAP are received in connection with the performance of services. These amounts are includible in gross income as compensation for services to the extent such payments exceed the fair market value of the property relinquished in exchange for such payments. Additionally, such payments are wages for Federal Insurance Contributions Act (FICA) tax purposes, including Medicare.

Effective for payments made after November 11, 2003, the MFTRA generally exempts from gross income any amounts received under HAP. Amounts received under HAP are also not considered wages for FICA tax purposes, including OAHI (Medicare). The excludable amount is limited to the reduction in the fair market value of property.

Time Limits for Filing Returns

Individuals generally must file their federal income tax returns by April 15 of the year following the close of a taxable year. Treasury regulations provide an additional automatic two-month extension (until June 15 for calendar-year individuals) for U.S. citizens and residents in military or naval service on duty outside the United States on April 15 of the following year (the otherwise applicable due date). No action is necessary to apply for this extension, but taxpayers must indicate it on their returns. Unlike most extensions, this applies to both filing returns and paying the tax due.

In general, individuals must make quarterly estimated tax payments by April 15, June 15, September 15, and January 15 (of the following taxable year). Wage withholding is considered to be a payment of estimated taxes.

Suspension of time periods. In general, under prior law, the period of time for performing various acts under the tax code, such as filing tax returns, paying taxes, or filing a claim for credit or refund of tax, is suspended for any individual serving in the U.S. armed forces in an area designated as a “combat zone” during the period of combatant activities. An individual who becomes a prisoner of war is considered to continue in active service and is therefore also eligible for these suspensions of time provisions. The suspension of time also applies to an individual serving in support of such armed forces in the combat zone, such as Red Cross personnel, accredited correspondents, and civilian personnel acting under the direction of the armed forces in support of those forces. The designation of a combat zone must be made by the President in an Executive Order. The President must also designate the period of combatant activities in the combat zone (the starting and termination date of combat).

The suspension of time encompasses the period of service in the combat zone during combatant activities in the zone, as well as 1) any time of continuous qualified hospitalization resulting from injury received in the combat zone, and 2) time missing in action, plus the next 180 days.

The suspension of time applies to the following acts:

• Filing any income, estate, or gift tax return (except employment and withholding taxes);
• Payment of any income, estate, or gift tax (except employment and withholding taxes);
• Filing a petition with the tax court for redetermination of a deficiency or for review of a decision rendered by the tax court;
• Allowance of a credit or refund of any tax;
• Filing a claim for credit or refund of any tax;
• Bringing suit upon any such claim for credit or refund;
• Assessment of any tax;
• Giving or making any notice or demand for the payment of any tax or with respect to any liability to the United States in respect of any tax;
• Collection of the amount of any liability in respect of any tax;
• Bringing suit by the United States in respect of any liability in respect of any tax; and
• Any other act required or permitted under the internal revenue laws specified by the Secretary of the Treasury.

Individuals may perform any of these acts during the period of suspension. Spouses of qualifying individuals are entitled to the same suspension of time, except that the spouse is ineligible for this suspension for any taxable year beginning more than two years after the date of termination of combatant activities in the combat zone.

Effective for any period for performing an act that has not expired before November 11, 2003, the special suspension of time period rules applies to persons deployed outside the United States away from the individual’s permanent duty station while participating in an operation designated by the Secretary of Defense as a contingency operation or that becomes a contingency operation. A contingency operation is defined as a military operation, designated by the Secretary of Defense, in which members of the armed forces are or may become involved in military actions, operations, or hostilities against an enemy of the United States or an opposing military force, or results in the call or order to (or retention on) active duty of members of the uniformed services during a war or a national emergency declared by the President or Congress.

Above-the-Line Deduction for Overnight Travel Expenses

Prior to MFTRA, National Guard and Reserve members could claim itemized deductions for their nonreimbursable expenses for transportation, meals, and lodging when they traveled away from home (and stayed overnight) to attend National Guard or Reserve meetings. These overnight travel expenses were combined with other miscellaneous itemized deductions on Schedule A of the individual’s income tax return and were deductible only to the extent that the aggregate of these deductions exceeded 2% of the taxpayer’s adjusted gross income. No deduction was generally permitted for commuting expenses to and from drill meetings.

Effective for taxable years beginning after December 31, 2002, MFTRA provides an above-the-line deduction for the overnight transportation, meals, and lodging expenses of National Guard and Reserve members who must travel more than 100 miles (and stay overnight) away from home to attend National Guard or Reserve meetings. Accordingly, the individuals incurring these expenses can deduct them from their gross income regardless of whether they itemize deductions. The amount of the expenses that may be deducted may not exceed the general federal government per diem rate applicable to that locale. Also, the amount of the expenses that may be deducted is available only for any period during which the individual is more than 100 miles from home in connection with such services.